The authors find that, "the automatic, unconscious process of learning by 'doing' becomes more effective if deliberately coupled with the controlled, conscious attempt at learning by 'thinking'" (p. 6). "In particular," they note, "we find that individuals perform significantly better on subsequent tasks when they think about what they learned from the task they completed." (p. 5).

Reflecting on one's learning--a staple of those who make rigorous use of trading journals--appears to help abstract and cement lessons derived from practice. Putting hours in front of a screen observing and trading will not necessarily generate maximum and learning and expertise unless there is also a processing of that experience. It is that processing that makes sense of the experience and frames future experience.

There is another important takeaway from the authors' research, however. Reflection provides emotional as well as cognitive benefits. Their study found that reflection resulted in higher levels of self-efficacy. When people reflect on their performance, they feel more capable of achieving and reaching goals. It is as if cognitive mastery imparts a personal sense of mastery.

This invites an interesting hypothesis: Effective reflection on successful experience might be particularly effective by keeping self-efficacy high and sustaining the flow state in which performers stay immersed in their craft. Such a hypothesis supports a solution-focused approach to coaching and mentorship.

Can traders guide their processes of reflection in the service of self-coaching? That will be the topic of my next post in this series.

Friday, May 30, 2014

The recent post on mentorship and coaching emphasized the importance of both role modeling and skill building in developing elite performance. A perusal of StockTwits uncovers a variety of experienced traders who have offered guidance to others. A few that come to mind are Brian Shannon of AlphaTrends, David Blair of CrosshairsTrader, Steve Spencer and Mike Bellafiore of SMB, Jim Dalton of J. Dalton Trading, Terry Liberman of WindoTrader, and Charles Kirk of The Kirk Report. If there are others you recommend who offer mentorship either formally/commercially or informally, please feel free to make suggestions via comments to this post.

Charles Kirk recently posted an article that emphasized the need to eliminate hero worship from trading. He makes excellent points: independence of thought is essential to trading success. It is difficult to stick with an idea if it is not genuinely *your* idea.

One of the great transformations that occurs during mentorship and coaching is the transition from hero worship to a stage of greater independence. Budding artists begin by copying the masters but, as they master elements of their craft, they experiment and discover their own "voice". Similarly, a new quarterback on the football field will start out starry eyed in worship of a legendary coach, but eventually will have the confidence to call an audible and change the planned play.

A child misses something in development if he or she doesn't have parents who are heroes. That child also misses something if he or she does not evolve beyond hero worship. It's the hero worship that facilitates an early internalization of attitudes and skills. It's emotional and intellectual independence that allows one to cultivate new attitudes and skills.If you read the biographies of successful traders, you'll find that most were mentored by successful traders--and yet none ended up as clones of their mentors. Who among experienced traders hasn't been inspired by one or more of the Market Wizards captured by Jack Schwager? But in markets, as in Oz, Wizards look quite different from the other side of the curtain. In recognizing the limitations of our heroes, we take the next steps in finding our greatness.Further Reading: The Heroic Dimensions of Trading
.

Thursday, May 29, 2014

How do people develop in high-performance fields?If you look at training programs, you'll generally find two components: mentorship and coaching.Mentorship is teaching and role-modeling the right attitudes, behaviors, and skills. Coaching is helping trainees practice and internalize those skills.Many times in training programs, upper level trainees serve as coaches, while senior professionals offer broader mentorship. For example, in medical school, an attending physician might explain and demonstrate a surgical skill, but it will be a resident who will actually supervise the student's practice of that skill and deliver needed feedback and guidance.

"Each one teach one" is a motto of medical education. The experienced physicians mentor; the advanced trainees coach--everyone is both teacher and learner.

Each one teach one also occurs in the military. Officers offer leadership and mentoring to trainees, but it's the seasoned veteran soldiers and drill sergeants who coach the skills and oversee performance. Similarly, senior players on a team (and assistant coaches) will help rookies build skills, while the head coach serves as mentor.

Of course, mentors can coach and coaches can mentor. The iconic basketball coaches in college, for example, lead and teach. Rarely, however, can training programs get away with having a single person as coach and mentor. The demands of deliberate practice are sufficiently intensive that assistant coaches and support from senior players become necessary. With that division of labor, it is crucial to mentorship and coaching in performance fields that both are daily and both are integrated. Combined, the two result in professionalization. A trainee becomes a professional by internalizing the lessons of mentors through guided practice and coaching. When I trained to become a psychologist, I had classroom teachers and advisers (mentors) and I had clinical supervisors who reviewed recordings of my therapy sessions with me (coaches). The learning was far more than absorbing facts and figures: it was cultivating a set of attitudes, ethics, behaviors, and skills.I could take a class at a local college, but no one would pretend that I am undergoing training in a performance field. Indeed, I could take a series of classes at school and learn plenty of facts and figures and never develop as a performance professional. It is the integration of mentorship and coaching in the service of skill development that separates performance training from simple education.In the trading arena, mentorship and coaching have notably existed within investment banks. Indeed, several banks, have been well-known for their efforts in training and mentoring. It has not been unusual to see graduates of the good bank training programs go on to become successful mentors themselves within banks and hedge funds. With Volker Rule/Dodd Frank restrictions on the trading activities of banks, however, it's difficult to imagine that banks will be in forefront of future training efforts for traders.Coaching and mentorship does occur between hedge fund portfolio managers and their assistants, but rarely is this organized and programmatic. It is quite unusual to find a dedicated Tiger cubs-style effort at funds, especially when it's been relatively easy up to now to recruit the promising professionals fleeing reduced opportunity sets at the banks.At the proprietary trading and retail level, too often mentorship and coaching are subsumed under the umbrella of "trading education". But courses in technical analysis and the like are no more training than those courses at the local college. Without intensive, integrated mentorship and coaching, no amount of education can provide performance training. Few trading firms possess the resources to develop ongoing, programmatic efforts at mentorship and even fewer can integrate hands-on, daily coaching with the learning from mentors.Consider the sobering issue of the high failure rate among individual traders and investors. Might that failure rate simply be a function of trying to succeed in a performance field without the requisite performance training? After all, would we expect someone to perform at the Olympics if they have not been systematically mentored and coached? Would we expect positive outcomes from a surgeon who did not undergo a rigorous program of mentorship and skill-based coaching?With banks and their training efforts less at the trading forefront, there is a tremendous opportunity for the right financial organizations to develop the next generation of trading talent. Such an effort, I suspect, would have to begin with the recognition that mentorship and coaching are themselves performance domains that can be cultivated within trading firms. Many times they are occurring on their own, informally at various desks. Learning from the successful efforts and leveraging those lessons is a first step toward building a self-renewing performance culture that grows profits by growing talent.Further Reading: Self-Coaching
.

Wednesday, May 28, 2014

In life, as in the gym, there is no such thing as comfortable change. Change requires moving beyond one's comfort zone and challenging one's limits. With those challenges comes uncertainty, fear, and anxiety. What makes us most comfortable--most free of fear--is precisely what keeps us from changing. As the saying goes, if you change nothing, nothing will change. The comfortable life is the static life.The implications of this view are profound. We think of anxiety and fear as negative emotions. We focus on limiting, eradicating, or coping with those feelings. As the quote above suggests, however, anxiety and fear yield energy. That flight or fight response aroused by an anxiety-producing situation can disorganize us--or it can propel us to challenge our limits. A great deal of performance success consists of making a friend of fear: using it to motivate and energize fresh responses to challenge. Are you afraid of taking a loss? Afraid of growing your sizing and risk-taking? Afraid of expanding into new trading instruments or approaches? Afraid of looking foolish by going against consensus thinking? Consider the possibility that fear is pointing the way toward your growth. Fear is giving you the energy to take appropriate losses, grow your trading, expand your universe, and exercise your independent thought. If fear is your friend, pointing the way toward your growth, perhaps your deepest confidence will come from seeing--first hand--that you truly can master what you're afraid of. Every fear is an opportunity for mastery.Successfully facing anxieties yields ever higher levels of security.The trader who totally controls emotions is the trader in his or her comfort zone, not the trader who is growing and adapting. Anxiety is a problem waiting for a solution. It is comfort we should fear.Further Reading: Becoming Solution Focused
.

Tuesday, May 27, 2014

Having spent a week in Alaska amidst glaciers and all sorts of wildlife, I have a renewed appreciation for the mind-stretching value of new experience. Here are a few mind-stretching links to start off this shortened holiday week:* Useful list of top financial blogs and other top ideas from Abnormal Returns;

Monday, May 26, 2014

Here's an update of a 2009 post, showing how daily volatility in the S&P 500 Index varies as a function of daily volume. Specifically, we're looking at daily true range in percentile terms as a function of hundreds of millions of shares in SPY. What we can see is that, as volume comes out of a market, movement also becomes less. Since 2012, we've had 155 days in which daily volume in SPY has been under 100 million shares. The market has moved over 1% on a true range basis on only 11 of those days--about 7% of the time. When volume has been between 100 and 150 million shares, we've had 1+% days on 104 out of 283 occasions--over one third of the time. When volume has exceeded 150 million shares, 140 out of 162 occasions--over 86%--move by more than 1%.With VIX below 12 and recent volume at the bottom of the above range, we're seeing little average daily movement in stocks. Only 5 out of 17 days in May so far have displayed a true range exceeding 1%. What commonly happens to traders in such an environment is that they will attempt to construct trades with superior reward-to-risk ratios and implicitly set their profit targets too high. If their entry execution is good, the market will initially move their way, only to stall out and reverse before hitting the intended target. Hence the frustration many traders feel in a low vol environment: trades that used to go their way for a profit now fizzle out and have to be stopped for no gain or a small loss.It feels to a trader as if his or her style is no longer working. But that isn't precisely correct: the trading style may be working fine, but yielding less. The problem is not with the trading method, but with the trading expectations. The market continues to move some fraction of a true range each time unit; it's just that the range is shrinking in a lower volume environment. The lower the volume and volatility, the more the trading becomes opportunistic: make it, take it. Markets won't move much, so when they move your way, you have to be thinking about taking profits. The wrong strategy is scaling into trades once there is price confirmation; by the time there is price confirmation, the market is ready to reverse (just as you're sized largest).

This is why I find real-time monitoring of volume to be essential when trading the day timeframe. How much participation is coming into or out of the market will determine how far a market will move for or against me. Setting stops and price targets at the inception of the trade is important. Equally important is monitoring volume and volatility during the trade and adjusting those price levels accordingly. Automobile traffic shows the reverse pattern: as the volume of traffic increases on a given road, average speeds will decrease. Traffic can move 65 miles per hour on an open highway, but might crawl at 15 mph during rush hour. Drivers learn to adjust their speed to fit the volume of traffic. It's a good lesson for traders as well.Further Reading: Is There Opportunity in the Market?
.

Sunday, May 25, 2014

During the time I was in Alaska, I posted what I called Trader10P3: Ten Principles of Peak Performance for Traders. The principles were presented with questions, as I view the ideas as more than mere abstractions. Potentially, they offer a framework for self-assessment: Am I doing what I need to be doing not only to achieve success, but to maintain and extend it?Goal-setting, in and of itself, does not make one a peak performer, as so many broken New Year's vows attest. Goals need to direct effort, energize efforts, and structure efforts so that regular feedback can guide improvement. Goals also need to be salient: if they're not in your trading journal, they probably aren't occupying mindshare.As Tony Robbins has pointed out, goals also need to be potent: they must bring out the best in us. Many times, goal-setting fails because it does not inspire. Entries in journals about "I need to be more patient and wait for my trade" are well and good, but are they really specific enough to guide tomorrow's actions? Will such goals have us springing out of bed eager to face the day, or are they more like a parent's admonitions to eat your veggies?Think of it this way: If you aspire to make a consistent living from trading, you are aspiring to be world-class. Research suggests that the vast majority of market participants do not earn enough to overcome their trading overhead. Even fewer sustain such earning power. If you hope to make trading your career, you are hoping to be a world-class performer.But you cannot be world-class at performance unless you are world-class as something specific. A world-class pitcher needs world-class pitches or pitch placement. A world-class basketball player needs to be a world-class scorer, rebounder, or defender. Being good at a lot of things doesn't necessarily make you great at anything. To be world-class, you've got to be great.We can think about potent goals as greatness goals: goals that bring out world-class performance. It is one thing to frame a goal as "I need to be more patient"; quite another thing to embrace the goal of becoming world-class in entry execution. Impotent goals chide; potent goals challenge and inspire.

So now, review the Trader10P3 and ask yourself where you will be world class:

Saturday, May 24, 2014

What new directions in your trading have you pursued in the past year? What activities do you engage in each week to produce new ideas, methods, and perspectives? If growth occurs only when we push beyond our comfort zones, how are you pushing yours right now?

Friday, May 23, 2014

Willpower is a limited resource. How do you focus and renew your energies? How much result do you see from the effort you expend each day? If everything in life is use-it-or-lose-it, what are you using and what are you losing?

Thursday, May 22, 2014

Who are the people in your daily life? What are the activities that dominate your daily life? What experience of yourself is reflected to you through your interactions with those people and your participation in those activities?

Tuesday, May 20, 2014

How much of your time is explicitly devoted to understanding and adapting to changing market conditions? If market trends, volatility, and correlations were to shift dramatically in the next week, how would you adapt your trading?

Sunday, May 18, 2014

To what degree is your trading grounded in ideas that are observable and objectively verifiable? How does your trading process keep you self-aware and as free as possible from emotional and cognitive biases?

Friday, May 16, 2014

What are your distinctive strengths and talents as a trader? How, specifically, does your approach to trading make the most of them? How do you make sure you are playing to your strengths each trading day/week?.

Wednesday, May 14, 2014

I will be on vacation and away from markets and blogging for the next ten days. During that time, TraderFeed will feature 10 Principles of Peak Performance for Traders (Trader10P3). Each day, a new principle will be posted as a question for reflection. Together, the list will make for a thought-provoking score card by which you can assess your performance.One of the great challenges of trading is that it requires intense and singular concentration on markets, but also an equal focus on one's performance in those markets. That combination of market awareness and self-awareness enables traders to make the most of their "edges" in markets while also cultivating fresh sources of edge.It is interesting that very successful traders usually don't achieve monetary success and then walk away from markets. That is because what drives them is not just the outcome, but also the process: the ongoing challenges of market mastery and self-mastery. Even after the money has been made, the game retains its appeal.If your motivation is primarily to make money, you probably won't get to the point of career success, because the inevitable periods of drawdown will sap whatever drive is present. When the motivation is mastery, losing periods provide fuel for reflection, learning, and improvement. Money is the score card, but the performance engine is love of the game.Further Reading: Trading as a Performance Activity
.

Tuesday, May 13, 2014

For daytraders as well as swing traders, identifying a trend day early in its lifespan can be a profitable strategy. Here are four things I look for in identifying upward trend days, such as we had on Monday:1) The cumulative NYSE TICK on the day stays positive and rising through the session;2) The percentage of NYSE stocks trading above their day's VWAP remains above 50% through the session (see chart above);3) The number of NYSE stocks making new daily session highs vs. fresh daily session lows remains positive throughout the session;4) Major indexes stay above their opening price ranges throughout the session;Not all of these conditions will fire perfectly on each uptrending occasion, but most of them will. Note that each of the conditions is measuring an initial thrust upward and then sustained buying pressure with consistent, positive breadth. The key is recognizing these conditions relatively early in the trading session. I obtain my data from my e-Signal feed and use historical research to identify the degree of thrust and buying pressure that is most likely to lead to a trending outcome.Note that the failure to meet the above conditions can also serve as an alert to a potential range day. Identifying likely day structure as early in the session as possible is a very helpful skill for traders on the day timeframe.Further Reading: Identifying Day Structure

Monday, May 12, 2014

I recently posted a few observations about how the underperformance of small cap stocks relative to the large caps. Even more concerning to me has been how stocks making new lows have dominated new highs despite the large cap indexes hovering near their highs. As the chart above shows, we have consistently seen fresh three-month lows outnumber three-month highs across the broad universe of common stocks. Indeed, if we just look at the NYSE universe on Friday--a day in which the DJIA touched fresh highs--we see that 69 stocks made 52-week highs and 60 made annual lows. That is pretty poor breadth.

My leaning is to interpret such divergences bearishly. Still, with a VIX closing below 13 on Friday, it's far from clear to me that we're in bear territory. So I decided to investigate. Specifically, I went back to the start of 1990 and looked at all occasions in which the S&P 500 Index closed within 2% of its 200-day high under the following conditions: a) VIX < 15; b) new 52-week highs under 100; and c) new 52-week lows over 50. My database spit back 38 occasions. These included dates in: November/December 1993; October 1994; January through March, 1995; October 1995; June 1996; November/December 2005; April 2006; June 2007; August/September 2013; and November/December 2013. That raised my eyebrows. One advantage of being my age is that I've closely followed or traded all those markets. Those were not bear markets--and they were not markets on the brink of the bear.Indeed, looking across the 38 occasions, the next 20 trading sessions averaged a gain of 1.9% and the next 50 sessions averaged a gain of 3.51%, with only a handful of losing instances in each case.Now, my conclusion is not to jump in with both hands and buy this market. Rather, the data exercise has accomplished two things: 1) tempered my bearish leaning; and 2) illuminated the kind of market we are in.I find this to be true of data exercises in general. They offer a kind of perspective that checks assumptions and biases and can trigger new ideas as well. The historical perspective is not always the correct perspective, but it often is a fresh one--and there is value in examining one's assumptions critically.Further Reading: Top Ten Reasons Traders Lose Discipline
.

Muhammad Ali - "It isn't the mountains ahead to climb that wear you out; it's the pebble in your shoe."

Vince Lombardi - "The quality of a person's life is in direct proportion to their commitment to excellence, regardless of their chosen field of endeavor." Dean Smith - "What to do with a mistake: recognize it, admit it, learn from it, forget it."Michael Jordan - "I've missed more than 9000 shots in my career. I've lost almost 300 games. 26 times, I've been trusted to take the game winning shot and missed. I've failed over and over and over again in my life. And that is why I succeed."

Bob Knight - "Your biggest opponent isn't the other guy. It's human nature." Muhammad Ali - "I hated every minute of training, but I said, 'Don't quit. Suffer now and live the rest of your life as a champion."

Jerry Rice - "Today I will do what others won't, so tomorrow I can accomplish what others can't."

Marv Levy - "Football doesn't build character, it reveals character."

Arthur Ashe - "You are never really playing an opponent. You are playing yourself, your own highest standards, and when you reach your limits, that is real joy."Mario Andretti - "If you have everything under control, you're not moving fast enough."

Saturday, May 10, 2014

A number of people have been focused on the relative underperformance of small cap stocks versus large caps. Indeed, while the Dow Jones Industrial Average (DIA) touched new highs this past week, the Russell 2000 Index (IWM) was trading near multi-month lows. Particularly weak have been microcap shares (IWC).

As we can see from the chart above, tracking 100-day relative strength of the Russell 2000 and S&P 500 Indexes since 2000, it is not at all unusual for the smaller caps to go through extended periods of underperformance. While the current relative relationship is oversold, it is not at the extremes we witnessed in May, 2011; October, 2008; or May, 2002. Interestingly, those very oversold points in the relative relationship ended up heralding very good long-term buying opportunities for stocks.If we just look at 100-day periods of relative outperformance versus underperformance of the Russell 2000 Index, what we find is that forward returns for both Russell and S&P have been superior following small cap underperformance largely due to the influence of the above three instances. Occasions when we have been at points of Russell underperformance similar to the current level include March, 2004; April, 2006; April, 2010; and March, 2012. Those were corrective periods--but not necessarily precise market lows--that ended up being good times to be long stocks for the longer term. Similar occasions also include March, April, July, and October of 2007--a period when stocks were topping out longer term.

Bottom line is that: a) the underperformance of Russell 2000 stocks has tended to occur during corrective market periods; b) such periods have often led to superior longer-term returns; and c) underperformance similar to current levels can become greater underperformance during true bear markets before they lead to superior returns. Given that the current underperformance is occurring in a low VIX environment, it is not clear to me that we are witnessing a repeat of 2011, 2008, late 2007, or 2002. The underperformance of small caps has not been a precise timing measure for stocks but on average has occurred during periods of risk aversion that have yielded positive forward returns for investors over the medium term. Further Reading: Risk Aversion in 2006
.

I've been posting preparation (PREP) tweets most mornings via StockTwits that include a number of the market measures that I look at to help me gauge the coming trading day. Because of a very busy work and travel schedule, I won't be able to keep up those tweets, so here is a summary of how you can obtain the information for your own preparation.SPY targets:

Thursday, May 08, 2014

* Money flow, sector by sector, is measured by multiplying ETF price by the number of ETF shares outstanding and tracking over time. Since the start of the year, money has flown out of SPY. The consumer discretionary sector has seen the greatest percentage outflows; the utilities sector the greatest inflows, followed by the two commodity-related sectors. Sector rotation has dominated the year to date, with small caps and NASDAQ shares recently underperforming large caps and yield-related sectors (consumer staples, utilities) recently outperforming growth sectors (technology, consumer discretionary).

Wednesday, May 07, 2014

The rookie trader fails because of an absence of knowledge. The experienced trader fails because of an absence of wisdom.Many market failures occur when people enter cognitive and emotional states that override their wisdom. A mindful trader retains access to both knowledge and wisdom. Many trading failures are failures of mindfulness.Further Reading: Objectivism and Trading
.

Tuesday, May 06, 2014

The first post in this series took a look at how emotional experience impacts risk-taking and decision-making. As the above quote suggests, discussions of emotions and trading often focus on fear and greed. Two important, but lesser appreciated emotions that impact trading are frustration and fulfillment. The frequency with which you are in a flow state--a state in which you are wholly absorbed in what you are doing--is probably the best psychological test of all. The reason for this is that we are more open to experience when we are in the flow state; it is a mode of enhanced information processing.

The flow experience occurs when there is an optimal balance between the challenges we face and our level of talent and skill. When challenges overwhelm our abilities, we experience frustration. When we are insufficiently challenged, we experience boredom. Both frustration and boredom keep us outside of our doing. In the flow state, we are immersed in the doing, so much so that time can pass without our notice. As the diagram above indicates, much of what we experience in performance situations can be explained by the match or mismatch between skills and challenges.The British novelist and philosopher Colin Wilson observed that acts of will--often brought on by crisis--can overcome frustration and boredom and transport us to a flow state. "We spend most of our lives in monoconsciousness," Wilson writes, "a narrow state in which
we are only aware of the present moment. It could be compared to being
in a picture gallery but being forced to stand with your nose within an
inch of the canvas." When we can stand back from the picture and truly apprehend its beauty, our narrow state is expanded: the petty worries and concerns of the present no longer matter. This can only occur, however, if the picture absorbs our attention. It is the act of focusing--and sustaining a focus--that turns mere seeing into perceiving.

It turns out that there are physiological factors that account for Wilson's observation and the flow state. Our attentional focus is improved when our brain's prefrontal cortex receives a jolt of dopamine. When we experience something as intrinsically interesting, fun, and/or challenging, that jolt keeps us engaged in what we are doing. In an important sense, highly productive, creative people who have cultivated the ability to sustain flow states do so because of positive addictions.A recent post by Abnormal Returns offers trading rules for new retail traders. Tadas makes the excellent point that there are many opportunity costs associated with developing trading mastery. The time and effort required necessarily eat into other potential productive and rewarding activities. It only makes sense to forgo those opportunities if one can find in trading the quality of emotional experience that comes from the flow state.We can best learn and master markets if we are absorbed in them and their patterns. We can best sustain absorption if we structure our learning so that tackling challenges provides us with shots of dopamine, not frustration. It's not just about fear and greed: emotional experience is essential to trading mastery because it provides the conditions under which we best learn and perform.

Sunday, May 04, 2014

The first post in this two-part series took a look at process orientation and why it is important to trading. By breaking trading into component elements and identifying effective routines for each, traders can remain grounded in best practices that impart a profitable edge. That mapping of process elements to outcomes is crucial: devotion to process in the absence of a demonstrated edge can only make randomness routine. Effective process components are evidence-based. But how do successful traders develop those components?

An interesting commonality among the Market Wizards interviewed by Jack Schwager is that they have generally held strong beliefs about how markets behave and what is necessary for trading success. Their theories are different, but they serve a similar function: orienting traders or investors to unique opportunity. Indeed, market theories are the Wizard's attempts to explain how asymmetric opportunities exist within otherwise efficient financial markets.A good example of an orienting theory are the Principles outlined by Ray Dalio. As Dalio explains, "...those principles that are most valuable to each of us come from our own encounters with reality and our reflections on those encounters--not from being taught and simply accepting someone else's principles." An important implication of Dalio's insight is that principles spring from experience; they do not precede experience. We discover truth, rather than simply receive it.This means that elaborating your processes and strengthening them requires observation and testing: seeing what works and what doesn't; seeking explanations for why something works or doesn't; revising approaches based on observation and testing; etc.Core principles spring from basic ways that we approach the world. As a brief therapist, my solution-focused work emerged from a perspective of contextualism: what we observe is a function of context, not necessarily an intrinsic and enduring state of affairs. A person can be depressed in one set of life circumstances and happy and fulfilled in another. Contextualism means that I will not expect the same patterns to show up at work, home, and parties, but may observe regularities within each of those social settings.

In markets, one expression of contextualism is the identification of "regimes": stable, but transient market periods that often follow identifiable "rules". Just as I sought to understand the emotional and behavioral patterns of clients as a function of their life context, I naturally understand market behavior as a function of drivers that operate in a given regime.

But what are these "drivers" and how can we objectively determine whether they are uniquely correlated with future price movement? A great deal of defining and redefining drivers, testing and retesting them, occurs before they can become legitimate elements of process. Those drivers are discovered, not simply lifted from books or the pronouncements of gurus. Such discovery starts with the observation of regularities that exist within identified regimes.

Once you have anchored yourself in theory and used your principles to guide discovery, those market understandings become truly your own. It is much easier to sustain conviction in your trading if your trading is grounded in what you have directly experienced. When process begins with first principles, theory becomes quite practical, guiding our encounters with reality. In an important sense, how we trade is an expression of who we are. Further Reading: Toward a Cognitive Theory of Trader Performance
.

Saturday, May 03, 2014

We often hear of the importance of having a "trading process". But what goes into such a process and what is it so important to be process-driven? This two-part series will offer perspectives.In such fields as manufacturing and health care, a process orientation is essential to quality control. Surgeons, for example, operate under the guidelines of best practice routines to reduce complications and maximize outcomes. Reliance upon a standard set of procedures reduces the variability of outcomes.When Margie and I visited the Two Roads brewery in Stratford, CT, we were surprised to see how few people were involved in the brewing process. Almost everything was computerized and automated. This automation ensured that each step of the brewing occurred at exactly the right temperature, for exactly the right amount of time, with exactly the right amount of ingredients. Once the brewer has the desired recipe, the key to successful production is standardization: making the same excellent product every single time.

From a quality control vantage point, replacing subjectivity with objectivity is generally a desirable outcome. The expert chef can get away with estimating ingredients by adding "a pinch here", but most of us are not experts. If a machine can add the precise pinch, a potential source of error is removed.

In an activity such as trading, where emotions in the heat of battle can introduce wild elements of subjectivity, a process orientation is essential to success. Algorithmic trading is the Two Roads version of money management, where every decision is precalculated and automated. Yet even discretionary trading can be made rule-governed and process-guided. An analogy would be playing poker or chess: there are rules for making good and bad bets and good or bad moves on the board, even as there is considerable room for individual judgment. Similarly, a football quarterback may call an audible at the line of scrimmage to take advantage of a defensive alignment, but the play called will have been pre-structured and well rehearsed.The areas of trading that can typically be made more process-driven include:1) Research and idea generation: Procedures for coming up with good trade ideas and investment theses;

2) Trade expression: How to structure the trade to achieve optimal reward to risk;

3) Risk management: How to bet enough on the idea to achieve a desired return on capital, but also to avoid an undesired drawdown;

4) Trade management: How to handle the position once it is on, including points to stop out, scale in, scale out, and take profits;

5) Portfolio management: How to allocate capital across trades to diversify returns and optimize equity curves;

6) Self-management: Procedures you implement to keep yourself in an optimal state for recognizing opportunity/threat and making decisions under time and emotional pressure.Each of these areas can be mapped out and distilled into principles and checklists. The checklist for an equity long/short investor will necessarily differ from that of the daytrader, but the categories will be similar.If you are a process-driven trader, you can write a substantial essay for each one of those categories. Indeed, if you were seeking capital for your trading, questions about each of the six categories above, along with detailed examples, would anchor an effective interview.

If your essay or interview responses would consist of a few sentences of generalizations, you know that your processes can be elaborated and tightened up. Ultimately, your responses to the above should map to a distinctive and demonstrable edge in the marketplace. The goal is to figure out your best trading and then help you become as consistent as possible in enacting what you do best. Your process should be the distilled essence and procedural expression of your greatest strengths.

In the next post in this series, we'll take a look at how you can elaborate your processes and make them more robust.Further Reading: Reflections on Trading Process
.

Friday, May 02, 2014

If you look closely, you'll see something quite unusual: the large cap indexes, such as the Dow and SPX, have been making or have been close to making all-time highs. If we look at the broad universe of common stocks, however, we can see that more are making 3-month new lows than new highs. Indeed, this has been the case for the past five trading sessions, despite a rise in the large cap indexes over that five-day period.In a similar vein, we have made 10-day highs in SPX but only 50-60% of SPX stocks have been trading over their 10-day moving averages.

A little over 5% of small cap stocks have been making fresh 50-day highs, but a little over 7% have been making new 50-day lows. A bit under 32% of SP 600 small cap shares were trading above their 10-day moving averages when the DJIA made an all-time high.

A strong trend, like a strong tide, should lift all ships. A number of ships remain beached at the moment.Further Reading: Stock Market Breadth

Addendum - NRK chides: "In a very strong stock market, corrections will tend to be flat and rotational. The flip side of the "weak breadth" story is a market in which 30+% corrections in former price leaders cannot drag the broad market down. The upside breakouts in EFA and FEZ are worth keeping an eye, as is the ability of EEM to hold above its March lows. An upside resolution of the flattish correction could easily spark a global growth story."
.

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), and Trading Psychology 2.0 (Wiley, 2015) with an interest in using historical patterns in markets to find a trading edge. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab). I teach brief therapy as Clinical Associate Professor at SUNY Upstate in Syracuse, with a particular emphasis of solution-focused "therapies for the mentally well". Co-editor of The Art and Science of Brief Psychotherapies (American Psychiatric Press, 2012). I don't offer coaching for individual traders, but welcome questions and comments at steenbab at aol dot com.